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Overview

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Overview

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  1. Overview • Demand • Supply • Underlying principles • Factors impacting supply and demand • Special S&D curves • Chapter 4 in text

  2. Demand • Various quantities of a commodity that an individual is willing and able to buy as the price of the commodity varies holding all other factors constant.

  3. Law of Demand • All else equal consumers will by more of a item at lower prices and buy less at higher prices. • Demand begins with individual consumer • Inverse relationship between quantity and price • Two dimensional, Price and Quantity

  4. Downward Sloping Demand Curve Px A PA B PB D QA QB Qx

  5. Downward sloping demand • Begin with individual’s utility function and a budget constraint • Substitution effect • consumers buy what’s cheaper • Income effect • “income” increases if prices fall

  6. Representation of Demand P Q Q = 14 – 2xP

  7. Market or Aggregate Demand • Add individual demand curves • Horizontally across consumers • http://www.aaec.vt.edu/rilp/Demand%20Changes-2000.pdf (Pages 1-10)

  8. Aggregate Demand • Add horizontally across consumers at each price Market 1 2 3

  9. Change in Demand orin Quantity Demanded Moving from A to B due to a price decline is a change in quantity demanded by moving along the same demand curve. Px A A shift in demand is a move from B to C as the curve shifts from D1 to D2 B C D2 D1 Qx

  10. Factors that Cause a Shift in Demand • Price of substitutes • Price of complements • Consumer income • Taste and preferences • IS NOT FUNCTION OF THE GOOD’S OWN PRICE

  11. Factors that cause a shift in aggregate demand • Population • Exports • Consumer income • Advertising • New information • Product differentiation • New product development • Government intervention

  12. Observing Demand in Data • Each P and Q are an equilibrium point where supply equals demand at a point in time. • Demand typically more stable • As supply changes the demand curve is traced out

  13. US Corn Price, 1995-96 to 2004-05 Crop Years

  14. US Corn Price, 1995-96 to 2004-05 Crop Years

  15. US Soybean Price, 1996-97 to 2004-05 Crop Years

  16. US Soybean Price, 1996-97 to 2004-05 Crop Years

  17. Per Capita Consumption in Pounds

  18. Per Capita Consumption in Pounds

  19. Inverse Demand • Price is a function of quantity • P = f(Q) • Important in agriculture • Short run supplies are relatively fixed • Prices change to clear the market

  20. Supply • The amount of a given commodity that will be offered for sale per unit time as the price varies, other factors held constant.

  21. Law of Supply • An economic principle that states: All else equal, producers are willing to sell more products at a higher price than at a lower one. • Positive relationship between price and quantity • Curve slopes up and to the right

  22. Supply • Derived from cost function • Production function • Input - output relationship • Assume that firms seek to • Maximize profits • Minimize costs • Supply starts will individual firm

  23. Production Function Output Total Product Decreasing returns to the input Increasing returns to the input Input

  24. Cost Curves • Average variable cost = AVC • Total variable cost / Q • Total variable costs change with Q • Average fixed cost = AFC • Total fixed cost / Q • Total fixed costs do not change with Q • Average total cost = ATC = AVC+AFC

  25. Cost Curves • Marginal cost = MC • Change in total cost by producing 1 more • TC / Q

  26. Cost curves Cost MC ATC AVC AFC Q

  27. Profit for the firm • Profit = total revenue - total cost • TR= P x Q • TC = ATC x Q • Profit per unit = Profit/Q • = TR/Q - TC/Q • = P - ATC • Profit maximizing Q • MC=MR=P • Profit/Q = P-ATC at optimal Q

  28. Optimal Q at P=MC Cost MC P2 ATC AVC P1 Q1 Q2 Q

  29. Cost curves and supply • Operate if ATC > P > AVC • Shut down if P < AVC • Lose on every unit produced • P>AVC make some payment to fixed cost • In the long run everything is variable • Short run defined by having fixed cost • Long run supply curve for individual • Low point on ATC curve

  30. Supply curve • MC curve above AVC curve • Upward sloping curve • Optimal output @ MC = MR • MR = Price => Optimal at MC=Price • The last unit of input just pays for itself • The change in the cost of the last unit is equal to the change in revenue of the last unit.

  31. Example Cost Curves for Corn

  32. Market or Aggregate Supply • Combination of individual supply schedules • Add horizontally across firms A B C Market

  33. Market supply curves S1 Move from A to B is a change in quantity supplied due to a price decline. Px S2 A B C Move from B to C is a shift in supply. Qx

  34. Supply Shifts from Change • in input prices • in returns for competing enterprises • in price of joint products • in technology on yields or costs • in yield and/or price risk • institutional constraints • SUPPLY DOES NOT CHANGE DUE TO A CHANGE IN PRICE OF THE OUTPUT

  35. Following Supply Shift • Firm level decision to supply shifter • Market impact of firms’ decision • Firm response to price reaction

  36. Supply Shift from Cost S1 Cost MC2 S2 MC1 P1 P2 D Q1 Q2 Q Q1 Q2 Q Firm Market

  37. Steps to shift curves • The impact changes the MC curve of the firm. • The firm chooses output so that MC = MR. • Market supply shifts. • Price moves along demand curve to new level. • Repeat steps 2 - 4.

  38. Market supply curves flatten out over time SLong run SShort run Px Qx

  39. Price and Costs in Ag • Short run • Not necessarily a relationship between cost and price • May be profit or loss • Long run • Firms expand output to profits and reduce output to losses • Average price = Minimum Long Run ATC

  40. Economies of scale • Average total costs changes as the output of a firm changes • Increasing, decreasing or constant economies of scale. • Short run cost curve (SRATC) • Long run cost curve (LRATC) • Change across range • L-Shaped cost curve

  41. Externalities and cost curves Cost • Cost or benefit not perceived by the firm • Internal cost curve • Cost curve if external cost included Q

  42. Processing cost curves • Specialized plants/equipment • High fixed cost • Low flexibility Cost SRATC Q

  43. Law of One Price Definition: Under competitive market conditions all prices within a market are uniform after taking into account the cost of adding place, time, and form utility.

  44. Marketing Adds Value • Time utility: Storage • Form utility: Processing • Place utility: Transportation • Does the added value offset the added cost? • Is the cost the same for everyone?

  45. Law of One Price • Reason the Law of One Price Works: Arbitrage • Profit seeking individuals acting in their own self interest • Sellers, Buyers, Middlemen • Buy low and sell high for profit by changing time, space, and form

  46. Law of One Price • Arbitrage opportunities • Transportation • Storage • Processing • How much price difference is sustainable between the two markets?

  47. Seasonal Grain Prices • Storable commodity • One harvest period • Used throughout the year